Derivatives strategies: Indicators point to some more downside in Nifty

The Nifty has edged down although it continues to be within a trading range. Background signals suggest it is increasingly likely to continue heading down. The VIX is rising, indicating increasing trader-nervousness. Breadth is negative with advances outnumbered by declines. Volumes are low. Geopolitical tensions continue. The trade war with America verses the rest could result in a global downturn. Crude prices continue to rule high.

The Nifty tested resistance at 10,900 unsuccessfully on June 13, topping out at 10,893. It has since fallen, to a low of 10,557 last week. This creates a falling top pattern compared to the prior high of 10,917 on May 15. On the downside however, the recent lows are at 10,425-10,450 levels, just above the 200-DMA, which is at 10,425. Trend-followers will be short, with a stop-loss at around 10,775-10,800.

The index could break that 10,425 support and drop below the 200-DMA to confirm a full-scale downtrend. Or it could climb above 10,917 to stabilise the uptrend. It could continue to range-trade the 10,400-10,900 zone for an indeterminate period.

Foreign portfolio investors (FPIs) remain net, high-volume sellers. Retail investors have also sold. Domestic institutional investors, including funds, are the only buyers at the moment. Rupee volatility will continue, after it hit a new all-time low last week. The FPI selling causes immediate pressure and the worsening Trade Balance and higher Current Account Deficit are causes for concern.

The dollar is likely to strengthen some more, given the current patterns of trading in the forex market. The Reserve Bank of India may be forced to intervene again, in order to manage the downtrend. Trend-following signals suggest staying long on dollar. But there's a case for shorting the yen and also maybe, for shorting the pound.

The Bank Nifty is at 26,250. A long July 26, 25,000p (74), long July 26, 27,500c (38) strangle could be hit in four or five trending sessions. The cost of this zero-delta position could be reduced with short July 12, 25,000p (18), short July 12, 27,500c (8). Note the premium differences, it shows how pessimistic traders are.

The Nifty is at 10,657. A long July 10,800c (69), short 10,900c (39) costs 30, pays a maximum of 70, this is 143 points from money, or two trending sessions away, given an average swing of about 95 points per session. A long July 10,500p (82), short 10,400p (58) costs 24, pays a maximum 76. This is about 157 points from money. Both positions seem reasonable from the risk:reward perspective. But the technical signals favour the bearspread.